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The Dangers of Liquidating Your Retirement Account

Posted by: Kelly Locke on Monday, October 5, 2015

A financial advisor would certainly advise against borrowing or liquidating a 401(k), IRA, or qualified retirement account.  If the penalties and taxes are not deterrent enough, then the realization that you are robbing from your future (retirement) and your money is no longer working for you should be plenty reason.  Approximately $70 billion dollars per year are withdrawn from retirement accounts for non-retirement purposes. Penalties and taxes attributed to that figure, total an estimated $21 billion.

 What are the dangers of liquidating?

  1. Robbing from your future: Liquidating a retirement account is robbing from your future. You may feel that you NEED the money today and it is worth the penalties and taxes, but you need to ask yourself what is going to happen when I am 70 years old and really need the funds.
  2. Penalties of 10%: For every $100 dollars you borrow, you are penalized $10. So if you need $100,000 you actually need to liquidate $111,100 to pay the $11,100 penalty fee. With low interest rates, getting a loan is a far better option than liquidating your retirement account and paying 10%
  3. Taxes: When you withdraw money from your retirement account, regardless of age, you will pay taxes on it as it is treated as ordinary income. Add taxes to your penalties and if you need $100,000, you may need to liquidate over $120,000 to pay the penalties and taxes. 
  4. Loss of compounding: The money in your retirement account is compounding. As profits are generated through dividends and gains, that money is reinvested. Liquidating a retirement account looses the compounding gain advantage, even if you plan on paying it back.
  5. Opportunity Loss: When you are out of any investment or do not have capital to invest, you miss opportunities.

What about 401(k) Loans?

If you happen to be in a 401(k) plan that allows borrowing, there are some limitations. You may borrow up to 50% of your 401(k) with a max of $50,000, but require it to be repaid within five years. There are some additional risks to consider:

  1. Fail to pay: If you fail to make a payment in 90 days, it is considered a withdrawal and you will pay taxes on it, plus a 10% penalty if you are under the age of 59 ½. 
  2. Double Taxation: You are paying back the 401(k) loan with after taxed money. Later when you withdraw the money, you will be paying taxed on the money again.
  3. Suspended Contributions: Many plans require you to repay the loan first, before making any contributions.
  4. Fees: Many 401(k) loan programs have fees for origination and administration. These fees could amount to 10% or even more, as they may be fixed fees.

Is there a better way? 

A retirement plan is for your future, but at the same time the needs to access capital today can be equally important.

  1. Home Equity Line: Home equity lines are similar to mortgages and a home is used as collateral. With low interest rates this may be a far better option than liquidating a retirement plan.
  2. Margin loans: Margin loans are loans against financial securities.
  3. Secured Loans: Traditional loans against savings accounts or bank CDs.
  4. Relationship Lending: This offers the most diverse option.

You can read more about types of loans and credit here: Understanding Credit and Loans

Before liquidating a retirement account, exhaust your other options first. If you are interested in a solution to your needs, please call Lendacy today. Let us help you navigate options so you do NOT have to liquidate your retirement account.